A lesson from the Oracle's trading in 2008
Rupert Hargreaves
Mar 31, 2020
In times of extreme market stress, investors can be spoilt for choice when it comes to finding value investments.
Indeed, a quick screen of the market tells me that there are more than 200 stocks with a market capitalization of more than $800 million currently trading at a price-to-tangible book value of less than 1.
This suggests that after a decade of rising valuations and limited opportunities, value investors now have plenty of options when it comes to finding stocks that are trading below liquidation value.
However, there's no guarantee that any of these businesses will ever recover from the current levels and generate a positive return for investors.
Losses are unavoidable
This is something every value investor has to consider before establishing a position. There is no quick formula that will tell you which companies are guaranteed to produce a positive result.
That's why when he first published his value investment strategy back in the 1930s, Benjamin Graham advocated holding a portfolio of at least 30 stocks. Walter Schloss frequently owned more than 100 equities and in the early days, while Warren Buffett (Trades, Portfolio) also invested in a broad selection.
Value investors understood there was never any guarantee every stock would produce a positive return. Nevertheless, by buying at a deep enough discount, the profits from those that recovered would more than offset any losses. It is essential to acknowledge this whenever we invest. Sometimes we will have to take a loss. That is just part of investing.
How investors react to these losses is what separates the good from the bad. Good investors take the loss on the chin, get up and move on. Bad investors try to take revenge on the market, average down into losing positions and avoid selling when there is no hope of recovery.
Buffett's mistakes
Even the best investors make mistakes. For example, in 2008, Buffett made several serious mistakes that ultimately cost Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) and its investors several billion dollars.
As the Oracle of Omaha explained in his 2008 letter to shareholders:
"I told you in an earlier part of this report that last year I made a major mistake of commission (and maybe more; this one sticks out). Without urging from Charlie or anyone else, I bought a large amount of ConocoPhillips (NYSE: COP) stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.
I made some other already-recognizable errors as well. They were smaller, but unfortunately not that small. During 2008, I spent $244 million for shares of two Irish banks that appeared cheap to me. At year end, we wrote these holdings down to market: $27 million, for an 89% loss. Since then, the two stocks have declined even further. The tennis crowd would call my mistakes "unforced errors."
Rather than concentrating on his losses, Buffett picked himself up and got on with the business of investing and running Berkshire.
As he explained, the crisis also offered plenty of opportunities for Berkshire to deploy billions of capital into other more attractive opportunities:
"On the plus side last year, we made purchases totaling $14.5 billion in fixed-income securities issued by Wrigley, Goldman Sachs (GS, Financial) and General Electric (GE, Financial). We very much like these commitments, which carry high current yields that, in themselves, make the investments more than satisfactory."
Buffett deployed $3 billion into General Electric, $5 billion into Goldman Sachs and $6.5 billion in Wrigley. These deals reportedly produced profits of $1.7 billion, $3 billion and $1.5 billion, respectively, for Berkshire over the next few years.
Based on my calculations, these profits more than offset the losses Berkshire suffered in 2008-2009, moving out of struggling companies.
This simple case study shows why it is often better to cut your losses as fast as possible and move on, even though it might be painful at the time.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- Investing in a Crisis: 5 Tips From Charlie Munger
- These Stocks Are Potentially Undervalued
- A Trio of High Earnings Yield Stocks
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